Working Paper: NBER ID: w25274
Authors: Xavier Dhaultfoeuille; Christophe Gaillac; Arnaud Maurel
Abstract: In this paper, we build a new test of rational expectations based on the marginal distributions of realizations and subjective beliefs. This test is widely applicable, including in the common situation where realizations and beliefs are observed in two different datasets that cannot be matched. We show that whether one can rationalize rational expectations is equivalent to the distribution of realizations being a mean-preserving spread of the distribution of beliefs. The null hypothesis can then be rewritten as a system of many moment inequality and equality constraints, for which tests have been recently developed in the literature. Next, we go beyond testing by defining and estimating the minimal deviations from rational expectations that can be rationalized by the data. In the context of structural models, we build on this concept to propose an easy-to-implement way to conduct a sensitivity analysis on the assumed form of expectations. Finally, we apply our framework to test for and quantify deviations from rational expectations about future earnings, and examine the consequences of such departures in the context of a life-cycle model of consumption.
Keywords: Rational Expectations; Subjective Beliefs; Testing Framework
JEL Codes: C12; D15; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| distribution of realizations being a mean-preserving spread of the distribution of beliefs (D80) | rational expectations can be rationalized (D84) |
| moment conditions hold (C62) | rational expectations cannot be rejected based on the available data (D84) |
| moment conditions not met (C62) | rational expectations do not hold (D84) |
| minimal deviations from rational expectations (D84) | substantial changes in predicted consumer behavior in response to income shocks (D12) |
| individuals without a college degree exhibit significant deviations from rational expectations (D29) | individuals with a college degree do not exhibit significant deviations from rational expectations (D29) |